Tax Changes for Those Coming Up on Retirement

If you’re planning to retire in the next few years, you may have wondered what may impact you from the new tax reform bill passed by the U.S. Congress in December 2017.  Officially called the Tax Cuts and Jobs Act (TCJA), there are a ton of changes in the bill, but only a small set that really affect your retirement decision.


Tax Changes for Those Coming Up on Retirement


Let’s focus on the items that may impact your upcoming retirement, and for the sake of this discussion, assume you are like the following—a married couple with $150,000 of pre-tax income, you may have dependents currently living with you, and you own a home valued at $250,000.  That will help narrow down all the changes.  Let’s dive in!


  • Decrease in marginal tax rates


By far the biggest headline of the bill is the decrease for many families on their marginal tax rate.  For our example couple with $150,000 in income, the marginal rates drop from 25% to 22%.  That’s substantial, but remember these are marginal rates, which means you don’t pay that level of tax on every dollar of income, just each dollar as you move up the brackets.  

This will apply to you if you’re planning to retire in the next few years (for that matter, it applies even if you don’t retire).  Since most retirees have some ordinary income, they should see a decrease in their marginal tax rate (but note that the very bottom rate, 10%, didn’t change in the new bill).  In general, this change in the tax code will free up some income from your federal taxes in retirement.


  • Capital gains thresholds stay with the old brackets


A subtler change happens for your income coming from capital gains and qualified dividends.  When you’re working, you may not notice tax on capital gains, since you are not taking money out of your stock and bonds accounts.  That usually changes once you retire, when you need to start selling assets from a taxable account (this whole enchilada doesn’t apply to “qualified” retirement accounts like 401(k)s and IRAs—those are taxed at “ordinary” income rates).

For our example couple looking to retire, the main planning item you should be aware of is not really a change in the tax code, but a change in the family’s situation—for years, you had ordinary taxable wages, and in retirement, you will likely have some capital gains on your investments as you draw down your savings (you’ll also have ordinary income from Social Security and 401(k) withdrawals).

The good news—capital gains/dividends tax rates are lower than your wage taxes!  Although the new TCJA tax bill didn’t change this part of the tax code much, make sure you’re thinking in terms of capital gains taxes for a pending retirement strategy!


  • Expanded standard deduction and elimination of personal exemptions


This change isn’t retirement-specific, but it is a big change in the tax code.  In the past, tax filers could claim “personal exemptions” for everyone living in their household.  That ended with the new bill.  Instead, taxpayers will get an expanded (almost doubled) standard deduction from taxable income.  For our example couple, the increased deduction means $2,700 less in taxable income!  


  • Qualifying dependent credit of $500


The bill includes a new $500 credit for qualifying dependents living in your home.  This could mean older children (older than 17) who are still living with you (e.g. a college student), or an elderly parent under your care.  For our near-retiree example couple, sandwiched between children who haven’t yet spread their wings and elderly parents who now are living in their home to receive extra care, this is a modest, but important, way to save on taxes!


  • Expanded medical expense deductions


Medical costs are an important factor in everyone’s retirement decision, and one key (but limited) tax deduction for medical expenses remains in the tax code (there was talk of eliminating it, but it squeaked by).  If your unreimbursed medical expenses (those not paid by insurance) exceed 7.5% of your Adjusted Gross Income (AGI), you can deduct the amount greater than 7.5%.  This applies to both 2017 and 2018, and after 2018, the threshold goes up to 10% again.  

For example, if our couple’s out-of-pocket medical costs were $20,000 for 2017, and their AGI was $150,000, then their 7.5% medical expense deduction starts at $11,250.  Meaning, they can deduct the amount over $11,250, or $8,750, from their taxable income.  

This deduction clearly is only important for people with high medical bills, but can be a big source of tax planning for retirees as you consider ways to save during retirement.


  • Qualified business income for pass-throughs


The last item that may sway your retirement planning affects you if you plan to do any freelance work or start an “encore” career after your primary retirement.  Under the new tax law, if you own a “pass-through business” (which can mean that you work for yourself as a sole-proprietor), you’re allowed to deduct 20% of your Qualified Business Income from your individual taxes.  Now, there are a lot of rules as to what constitutes Qualified Business Income, but for the most part, if you do contract work or otherwise run your own business, you can pay taxes on only 80% of your income going forward!

For example, suppose the wife in our soon-to-be-retiring couple was a successful attorney in her primary career, and would like to do some occasional work for her former firm during retirement.  As an independent contractor, she’ll need to pay tax on her net income (after subtracting any expenses as a contractor).  With the new law, her tax liability goes down 20%, which might sway her decision to keep doing part-time work in the future.  Not everyone plans to keep working for pay during their retirement, but if you do, this is an important change to consider!

Tax Changes as Part of Your Retirement Plan

Tax planning is a neglected part of many soon-to-be-retiree’s comprehensive financial plan. They rightly concern themselves with their income sources like Social Security and their assets, but forget that the annual tax burden also determines what quality of retirement they can expect.  Although the six changes I mention above as part of the Tax Cuts and Jobs Act of 2017 will impact retirees, it pays to take an overall look at your tax strategy.

Your situation is unique, and you always need to consult with your tax expert.  If you’re looking for help, schedule time with me!

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